MGIC Investment Corporation — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; filed February 27, 2015. MGIC is a holding company whose subsidiaries primarily provide U.S. private mortgage insurance.
Business context and reporting period
MGIC insures lenders against losses on low-down-payment residential mortgages. Nearly all recent insurance writings supported loans sold to Fannie Mae and Freddie Mac (the GSEs). In 2014, improving employment and housing conditions, declining defaults, and private mortgage insurers’ market-share gains supported a return to annual profitability. MGIC reported $33.4 billion of new primary insurance written and $164.9 billion of primary insurance in force at year-end.
Key financial and operating metrics
| Metric | 2014 | 2013 |
|---|---|---|
| Total revenue | $941.8 million | $1,039.4 million |
| Net premiums written | $882.0 million | $923.5 million |
| Net premiums earned | $844.4 million | $943.1 million |
| Net investment income | $87.6 million | $80.7 million |
| Net income (loss) | $251.9 million | $(49.8) million |
| Diluted earnings (loss) per share | $0.64 | $(0.16) |
| Losses incurred, net | $496.1 million | $838.7 million |
| GAAP loss / expense / combined ratios | 58.8% / 14.7% / 73.5% | 88.9% / 18.6% / 107.5% |
| Operating cash flow | $(410.0) million | $(971.5) million |
| Cash and cash equivalents at year-end | $197.9 million | $332.7 million |
| Shareholders’ equity at year-end | $1,036.9 million | $744.5 million |
Fourth-quarter 2014 net income was $74.4 million, versus a $1.4 million loss in fourth-quarter 2013. Fourth-quarter net premiums earned were $213.6 million and losses incurred were $117.1 million.
At December 31, 2014, investments had a fair value of $4.61 billion; approximately 100% of fixed-income investments were investment grade. Holding-company cash and investments were approximately $491 million. Holding-company debt was approximately $1.30 billion in principal, with annual debt service of about $66 million. Debt included $61.9 million of senior notes due November 2015, $345 million of 5% convertible notes due 2017, $500 million of 2% convertible notes due 2020, and $389.5 million of 9% convertible junior debentures due 2063.
MGIC’s statutory risk-to-capital ratio was 14.6:1, below the commonly applicable 25:1 limit; its policyholder position exceeded Wisconsin’s $1.0 billion minimum by $673 million. The company paid no common dividends in 2014.
Material changes versus prior comparable periods
- MGIC recorded its first full-year profit since 2006, reversing the 2013 loss. The 2014 result reflected sharply lower losses incurred and lower operating expenses, partly offset by reduced premium revenue.
- Losses incurred fell about 41% from 2013. Primary defaults declined 23% to 79,901 loans, and the primary default rate decreased to 8.25% from 10.76%. Net paid losses and loss-adjustment expenses declined to $1.15 billion from $1.79 billion.
- New primary insurance written rose to $33.4 billion from $29.8 billion; primary insurance in force increased 3.9% to $164.9 billion. Cancellations fell to $27.2 billion from $33.2 billion, turning the change in insurance in force positive.
- Net premiums earned declined about 10%, principally reflecting lower average insurance in force and greater premium ceded under reinsurance. Net investment income rose, while realized investment gains decreased substantially from 2012’s unusually large gains.
- The loss reserve declined to $2.40 billion from $3.06 billion; the reserve for the discontinued Wall Street bulk business declined to $23.8 million from $48.5 million.
Outlook, management commentary, risks and contingencies
- Management outlook: Management described the 2015 mortgage-origination outlook as stable versus 2014 and expected average insurance in force and direct premiums to increase. It expected paid claims to continue declining, but forecast further net cash outflow in 2015. Management said a greater purchase-mortgage share would benefit the business.
- GSE capital requirements: Under the 2014 draft PMIERs, MGIC estimated an Available Assets shortfall of about $600 million at year-end 2014 under stated assumptions, declining to about $300 million over two years through operations. The company expected to pursue reinsurance modifications, transfers of available funds (subject to approvals), and potentially non-dilutive debt. Final requirements and timing remained uncertain; loss of GSE eligibility could materially reduce new writings.
- Competition and pricing: The FHA cut annual premiums by 50 basis points effective January 2015. MGIC noted that this could weaken its competitiveness for some borrowers. Greater use of discounted lender-paid single-premium policies was expected to reduce average new-business premium rates and, management said, typically produces less lifetime premium than borrower-paid monthly coverage.
- Legacy credit and reserve risk: 2005–2008 books represented about 40% of primary risk in force and were still expected to produce a material share of losses for years. Loss reserves are judgmental and established primarily for loans already in default; actual claims may differ materially. Management estimated that a $1,000 change in average severity combined with a 1% change in the average claim-rate factor would change reserves by about $87 million.
- Liquidity and leverage: Operating cash flow remained negative despite reported net income, and claims payments had exceeded premiums received since 2009. Insurance-subsidiary dividends are restricted; MGIC had paid none to the parent since 2008. The parent’s debt obligations substantially exceeded its cash and investments.
- Legal and tax contingencies: For Countrywide-related claims and other probable settlements, the company estimated maximum exposure above its recorded best-estimate provision of $626 million; a further claims-practices exposure was estimated at up to $16 million. The IRS dispute includes notices for $197.5 million of taxes and penalties plus approximately $168.4 million of interest at year-end 2014, and a further $261.4 million largely related to a disputed NOL carryback; the company contested most adjustments in Tax Court. Potential state taxes and interest were estimated at $47.4 million, excluding possible penalties.
- Other risks and items: Re-defaults on modified loans, foreclosure delays, economic or home-price deterioration, changing state capital rules, GSE reform, and the outcome of regulatory or customer disputes could affect results. MGIC’s below-investment-grade financial strength ratings were Ba3 from Moody’s and BB+ from S&P. The audit opinion was unqualified, and the auditor reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether final PMIERs requirements, reinsurance changes, regulatory approvals, and available capital are sufficient to maintain MGIC’s GSE eligibility.
- Whether lower defaults and favorable prior-year reserve development persist, and how reserve assumptions compare with subsequent paid claims—especially for 2005–2008 vintages.
- Whether premium growth and profitability can withstand increased single-premium business, price competition, and the FHA’s January 2015 pricing reduction.
- How much liquidity is accessible at the holding company versus regulated subsidiaries, and the capacity to meet debt service and the 2015 senior-note maturity while cash flow remains negative.
- The ultimate cost and timing of Countrywide-related matters, other claims-practices disputes, and the IRS tax litigation, including effects on capital and cash.
- Potential dilution from convertible securities: diluted 2014 EPS used 413.5 million weighted-average shares versus 338.5 million basic shares; 338.6 million shares were outstanding at year-end.